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Study Session 9: Equity Valuation: Valuation Concepts

Fama-French Three-factor Model

a theoretical question: in the fama-french three factor model, we get required rate of return on equity from the following equation:

R= Risk-free rate + b1 * market risk premium + b2 * small-cap return premium + b3 * value return premium. Here, b stands for factor beta.

Intrinsic P/E vs Justified P/E

I bring this question up in response to CFAI 2011 PM Mock #57. In the book, they talked about justified P/E alot and importantly, always specified trailing or leading P/E. In this question they ask for the intrinsic P/E and do not specify. In the explanation they use the same equation as for justified forward P/E.   (1-b)/(r-g)

Does anyone know what the distinction is between justified and intrinsic or if we should assume forward P/E when it’s not specified?

Thank you

What is ROE?

According to Google “define ROE”:

“The mass of eggs contained in the ovaries of a female fish or shellfish, typically including the ovaries themselves…”

So my question is… which one of these is the correct definition?

A. ROE(2011) = Net Income(2011) / Book Value(2011)

B. ROE(2011) = Net Income(2011) / Book Value(2010)

C. Other: __________

Heads Up4: DDM or no DDM

Profitable company with earnings growing at 5% annually, pays a good dividend of $1.25 every year.  Would you use DDM to value the stock or not?  Why?

Heads Up3: Present value of the real cash flows

Nominal required rate of return 14%

Real required rate of return 8%

Present value of nominal cash flows discounted at 14%: Rs. 16.75 billion

Present value of real cash flows discounted at 14%: Rs. 12.25 billion

Present value of nominal cash flows discounted at 8%: Rs. 23.78 billion

The present value of the real cash flows discounted at 8% is closest to:

A. Rs. 14.06 billion.

B. Rs. 16.75 billion.

C. Rs. 23.78 billion

Economic Profit - why dollar value of WACC is ammortized

Hi guys,

When calculating the Economic Profit, which is equal to NOPLAT(1-T) - $WACC, the dollar wacc is ammortized due to the depreciation from one year to another. Depreciation is a pure accounting procedure, which doesn’t really relate to the economic benefits or losses. I don’t really understand the concept, thus.

Can you shade some light  on this?


Schweser Book 5 Exam 2 - PM Section

Re: Question 91. How do they calc the expected change in the P/E? The formula for the Ibbotson model is

(1+expected Inflation)(1+Real earnings)(1+change in P/E) - 1 + div yield - RF

They come up with a change in P/E of .97??? The problem says the market is overvalued by 10% and they don’t really give the expected change in P/E.

OK, so I just realized the baseline valuation for this is 0 and will change depending on over/under valuation. But, I still don’t see where they come up with .97?

ATOCF vs. NOPAT: does SGA count as a cost?

I’m just curious to know wether SGA is considered a cost in the ATOCF. I realize that one is a measure of cash flows while the other is a measure of profits. Still, I would think that SGA is a cost so that it should be included in both.

As I understand it, here are the equations for both measures:

ATOCF = (Sales - Costs - Depreciation)*(1-tax) + Depreciation

NOPAT = (Sales - Costs - SGA -Depreciation)*(1-tax)

Is there a reason why SGA is not in ATOCF?